The U.S. Court of Appeals for the Third Circuit has addressed the tension that may exist between the needs of a bankrupt debtor attempting to reorganize and the rights of nondebtor litigants in In re Philadelphia Newspapers, 2012 U.S. App. LEXIS 15419 (3d Cir. July 26, 2012). The Third Circuit held that the U.S. District Court for the Eastern District of Pennsylvania abused its discretion in finding that an appeal had been rendered equitably moot as a result of substantial consummation of the Philadelphia Newspapers debtors’ Chapter 11 plan of reorganization and the appellants’ failure to seek a stay. The Third Circuit held that the doctrine of “equitable mootness” may not be applied merely when a plan has been substantially consummated, but instead requires that the appeal at issue would actually undermine that plan.

Background

During the pendency of the cases in the U.S. Bankruptcy Court for the Eastern District of Pennsylvania, the debtors published an online editorial linking to certain articles published prepetition by The Philadelphia Inquirer regarding the management of a charter school. The managers of the school alleged that the articles were defamatory and that the online editorial constituted a “republication” of the allegedly defamatory material, and filed administrative expense requests in the Bankruptcy Court against the debtors, in the amount of $1.8 million, for the alleged damages caused by such postpetition act.

The debtors objected to the administrative expense requests and requested an expedited evidentiary hearing, which the Bankruptcy Court granted. Following the evidentiary hearing, the Bankruptcy Court held that the managers had failed to demonstrate their entitlement to an administrative expense, because the postpetition online links did not constitute a republication of the alleged prepetition defamatory material.

The managers timely appealed the ruling to the District Court, but did not seek a stay pending appeal. Before the District Court could rule on the merits, the debtors’ fifth plan of reorganization was confirmed by the Bankruptcy Court, and the debtors’ sale of substantially all assets pursuant to the plan, which had been delayed for unrelated reasons, was consummated. The District Court then ruled that the appeal was equitably moot, without analysis other than to note the substantial consummation of the debtors’ plan of reorganization and the failure of the managers to seek a stay.

Narrow Application of Equitable Mootness Doctrine

On appeal to the Third Circuit, the charter school managers challenged the ruling of the Bankruptcy Court on substantive grounds, but also took issue with both the Bankruptcy Court’s scheduling of an expedited hearing on the administrative expense requests, as well as the District Court’s determination that the appeal was equitably moot.

The Third Circuit gave little credence to the managers’ assertion that their due process rights had been violated in the Bankruptcy Court. Under Federal Rule of Bankruptcy Procedure 9006(c), a bankruptcy court has the discretion to set an expedited schedule for hearing a substantive motion “for cause shown.” In exercising this discretion, it should consider the prejudice to parties entitled to notice and weigh this against the reasons for hearing the motion on an expedited basis. Here, the school managers received notice of the hearing on the debtors’ objection to their administrative expense requests a week before the hearing took place. This proved to be a sufficient amount of time for the managers to prepare witness testimony and draft a detailed brief in opposition to the debtors’ objection. At the hearing on the motion to expedite, the Bankruptcy Court solicited the managers’ input on scheduling, albeit recognizing that the then-scheduled closing on the debtors’ asset sale did leave room for delay. Accordingly, the Bankruptcy Court did not abuse its discretion in hearing the debtors’ objection to the requests on an expedited basis, and the expedited hearing did not violate the appellants’ due process rights to notice and a hearing.

On the issue of equitable mootness, the Third Circuit held that the District Court’s analysis did not meet the rigorous standard required under the Third Circuit precedent, In re Cont’l Airlines, 91 F.3d 553 (3d Cir. 1996). Unlike constitutional mootness, where it is impossible for a court to grant any relief, equitable mootness reflects a choice by an appellate court to avoid deciding the merits of an appeal. Equitable mootness is “‘a shortcut for a court’s decision that the fait accompli of a plan confirmation should preclude further judicial proceedings. A court arrives at this decision through the application of prudential considerations that address concerns unique to bankruptcy proceedings,’” according to the opinion in Philadelphia Newspapers. These “prudential factors” are: (1) whether the reorganization plan has been substantially consummated; (2) whether a stay has been obtained; (3) whether the relief requested would affect the rights of parties not before the court; (4) whether the relief requested would affect the success of the plan; and (5) the public policy of affording finality to bankruptcy judgments.

The Third Circuit held that the District Court abused its discretion in finding equitable mootness without consideration of all of the prudential factors set forth above. In particular, the Third Circuit emphasized that the District Court misapplied the first factor — whether the debtor’s plan has been substantially consummated. This factor, which the Third Circuit identified as “typically the foremost consideration,” requires more than a mere surface inquiry; it instead “requires that a court consider whether allowing an appeal to go forward will undermine the plan, and not merely whether the plan has been substantially consummated under the Bankruptcy Code’s definition.” Although the debtors’ plan had been substantially consummated in a technical sense, the allowance of the appellants’ administrative expense requests on appeal would not upset the Philadelphia Newspapers plan, because the plan provided a mechanism for postconfirmation allowance and payment of claims. The Third Circuit effectively distilled the five Continental Airlines factors into a single rule: “a court only should apply the equitable mootness doctrine if doing so will ‘unscrambl[e] complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract.’” Here, the managers’ appeal could not unscramble the Philadelphia Newspapers plan of reorganization.

The Third Circuit elected to hear the school managers’ appeal, but nevertheless sided with the Bankruptcy Court and the District Court and held that the act of linking to an allegedly defamatory prepetition article on the Internet did not constitute republication of the article under Pennsylvania law. In the absence of any postpetition tortious conduct by the debtors, the administrative expense requests were properly denied.

Perception

There is perhaps a common perception that bankruptcy cases and related proceedings unfold in a “Wild West” where rights, including noneconomic rights of due process and appeal, will be abridged. The opinion of the Third Circuit in Philadelphia Newspapers illustrates, however, that when applied properly, bankruptcy practice and procedure are designed to strike a fair balance between the needs of the reorganizing debtor and the nondebtors. Thus, it was not improper for the Bankruptcy Court to hear and determine the appellants’ administrative expense requests on an expedited basis when the pending sale of the debtors’ assets provided valid cause for such treatment. Conversely, as the Third Circuit held, application of the equitable mootness doctrine should be limited to those situations in which the policy justification for that doctrine — preventing an appeal from undermining a confirmed plan of reorganization — will be served.■